Despite record demand for PMs (precious metals) among Asian Central Banks and retail investors worldwide, and despite the sell-off of Western mercantile inventories as gold heads to Asia, YTD price action on our markets does not encourage PMs as investment vehicles. Aside from their current appeal as a value and contrarian play, the direction of fiscal policies and degree of economic strength (or weakness) in major economies offers two very different outlooks for PM prices going forward. Note that while silver usually follows gold, behaving as a monetary metal in regard to spot bullion prices, its role as primarily a tech-industrial commodity could cause its price action to diverge from gold in the mid to long term.
A key point to grasp in examining this small but important part of the markets is that PM prices reflect policies and sentiment at the interface of economics, markets and monetary conditions. Monetary policies and economies are changing and perhaps will change profoundly. Let us look at some of the variables and the numbers tied to them.
Gold prices in USD have fallen 17% in just ten weeks ($1475-$1237/ oz.) and Spider Gold ETF (GLD) has plunged from $167 to $118/share YTD: the low was $114. That is about a 23% drop, while gold bullion has done nearly as badly. Since early April, silver has fared even worse, falling 30% from $28 to $18.72/oz. (SLV). Note that the gold/silver price ratio which ranged from 54-57:1 during 2012 in 2Q 2013 grew to 64:1. Trading July 8 saw both metals rise but at a 72:1 gold /silver ratio. This means that the upside for silver is greater, potentially much greater since the historic ratio is 16:1.
The fact that gold's rise may reflect changes in its monetary role in revised global banking and reserve systems does not mean that it will outperform silver. Sentiment for the latter will outweigh its primarily industrial function as far as trading and commodity prices go. Change in the depressed prices of both PMs will have slingshot effects on the miners that produce them. Share prices in the PM mining sector are extremely depressed.
The Fed and major banks prefer that retail investors turn in dismay from precious metals to equities whose relative strength is believed to affect purchasing and hiring decisions. A similar shift to stocks has resulted from crushed yields in bonds. This has created asset bubbles in both equities and fixed income, which began leaking, especially the inflated bond prices, after the Fed increased its taper talk in mid-May. Everyone has rushed to equities or cash since it is clear that gold is for losers. However, gigantic net long positions by commercials (banks) in both gold and silver as reported by the CFTC and COT ("commitment of traders") indicate that they have growing interest and they rarely come out as losers from such trades. These are the largest net long positions since 4Q 2001 when gold was $270/oz. These positions make the bullish case for PM prices for the rest of this year.
Many people focus on the troubles of gold miners whose woes result largely from depressed gold prices in the wake of increasing capex and acquisition that followed gold's 2009-11 rise. Pessimists may believe that waves of short-selling PMs could continue forever and that rules against "naked short selling" never will be enforced against major banks. Perhaps new sanctions announced and rules limiting derivative trading on opaque platforms, such as proposed by the EC, will fail to control derivative trading and the financial system and economies tied to it will become shakier. "Stress testing" and "network analysis" of shadow banking in the US might cause a flight to cash rather than PMs.
Maybe so, but that still leaves Asian nations and banks, especially that of China (and Indian and Chinese retail investors) acquiring massive amounts of gold, though this has declined a bit in the last two weeks as major firms like Morgan Stanley (MS), Credit Suisse (CS), UBS (UBS) and Goldman Sachs (GS) (again) have lowered target prices for 2014. While such calls chill outlook and tend to become self-fulfilling prophecies, buying has put a sturdy floor under PM prices that will become harder as recent and current cuts in mining capex and production resulting from the past 20 month price retracement make themselves felt in reduced supply. Still, Danske Bank (previous link) states gold will fall to $1000/oz by year-end, which would crush most of what is left of the PM mining sector. What factors could save the scenario for higher gold prices?
Canada has joined Germany in the hunt to become the first major Western nation whose Central Bank will freely exchange its currency with the RMB (yuan). Germany is acting to make Frankfurt a hub for yuan exchange and thus more closely interlink the world's second and third largest economies, the EU and China.
Turkey, Brazil, Australia and South Korea are among nations that already allow exchange of their currencies with RMB (Renminbi, "people's currency") for bi-lateral trade. Germany and the ECB are looking for an 800 billion yuan ($130) billion exchange facility for starters. In June, England agreed with China to initiate a 200 billion RMB-pound exchange. This pushes the move to ex-USD bilateral trading agreements between China and about a dozen major nations including Japan and Russia with those noted above. It seems clear that there will be a new world reserve system including an RMB whose position is buttressed by China's rapidly expanding gold reserves.
As for falling metals prices generally, note that since February, only five months Cu (copper) is down nearly 20%, from $3.80 to $3.08/lb. Clearly world economies are unwell and silver, being primarily an industrial metal that also is considered and bought for monetary and investment reasons, gets the double hit. Malaise in economies has begun to roil markets with investors unclear if the S&P 50-day moving average (1624) is working since late May as support or resistance.
While the shift underway to a new reserve system will rock economies and markets and thus, perhaps continues to push down copper prices, the link of gold reserves to the RMB and its soon to be numerous exchange facilities with all major nations indicates that the bullish case for gold is strengthening. If by some enchantment China does not use its growing gold reserves to support the RMB, the thesis would lose part of its force. It is, however, hard to believe that China is acquiring many hundreds of tons of gold each year (and over 300 tons in June) only to ignore its ability to buttress its growing monetary heft. As gold rises, and these monetary and trade dynamics make a significant rise likely, silver as usual will trade more like a monetary than a tech-industrial metal and rise even more strongly in the familiar inverse to its recently greater decline that has seen the gold/silver ratio grow to 66:1.
The impact of a new monetary structure on gold and silver ETPs (exchange traded products) and on the miners will be great. The sick would suddenly show signs of health. Not only the stricken Gold Junior Miners (GDXJ) and silver miners (SIL), but streaming companies like Silver Wheaton (SLW) and Sandstorm Gold (SAND) that give additional leverage to the metals for which they contract will reach and likely exceed the levels they were trading at last October. Mid-tier dividend payers with substantial reserves like Kinross Gold (KGC), Yamana (AUY) and IamGold (IAG) will suddenly find that their debt levels or falling cash flow and income growth are not chains of lead. Mid-tier PM miners like Eldorado Gold (EGO) and First Majestic Silver (AG) whose cash and equivalents are 4:3 to 6:1 greater respectively than their total debt will jump as rich sites nearing production or under development (EGO's Certej in Romania) come online. Debt-challenged majors, Barrick Gold (ABX) and Newmont (NEM), the latter with 3x the cash flow of ABX and $1,634 million net income, will be robust.
As health in the form of rising PM prices returns to the sector, "informed opinion" will change and with it investor sentiment. The historically tiny (1%) of American holdings in PMs will rise, further boosting prices. Instead of a tiny minority, most investors will want 5-20% of their holdings in physical metal ETPs like Sprott Gold (PHYS) or silver (PSLV). The change in reality that begets change in sentiment would help juniors with no debt like McEwen mining (MUX) or Tahoe Resources (TAHO) who will be able to accelerate rather than delay development of properties. Resource nationalism will lose its cachet as China ignores it while other nations scramble to keep pace.
Dr. Stephen Leeb, Chairman and CEO of Leeb Capital Management, is an award-winning investment strategist and holder of numerous patents in market analytic software. Dr. Leeb sees "no top" to the long-term gold bull and adds, "China has the right idea" in buying gold. He believes that new currency and reserve structures will see gold categorized as top-tier collateral, which by 2020 will take the price to "five figures" per ounce. If you peruse his biography and the work of his Plain Sight Analytics, spectroscopy and other patents and projects at Yale, you will see he is not a gold bug or cultist of any kind.
In the alternative, investors could continue to follow government and media narratives about positive "unemployment" trends and market strength. The media could build a mountain of "confidence" on retail sales growth although the current 4.3% rate is not even half that of July 2011. Perhaps consumers will buy despite shrinking work weeks and a workforce participation rate that remains in a 5-year decline from 66% to 63.5%, countering the official narrative. John Williams reports that full-time employment fell 240k jobs in June. The National PMI composite for June was 50.9 with one sector chief commenting, "slow growth continues to choke the recovery." The employment figure contracted to 48.7 so consumers are unlikely to push growth and the government will not cut regulations or taxes that drain life and fluency from the system they artificially inflate.
Economic problems in tandem with new currency, reserve system and banking arrangements could help bullion prices while leaving miners in poor shape. A significant downturn in global economies could impact miners, despite their contrarian appeal, along with other businesses. However, if demand for gold continues high among CBs (Central Banks) this will buffer further decline in gold miners with major sites.
It is likely that the Fed will continue to buy large, even larger amounts of debt to keep yields low and avoid crushing the housing and bond markets. But CBs have been dumping T-Bills, world economies look shaky and new ex-USD trading facilities involving the RMB signal that fundamental change is coming. The huge bond sell-off July 5 was a portent of plunges to come if demand, and thus prices for bonds sags. At the same time, the RMB will get stronger without crippling China's exports since banks and businesses from Toronto to Tokyo and Berlin to Rio and Melbourne will have their own RMB to loan and with which to buy. It also is possible that EU and American trade overseers will be able to enforce transparency on major bank trading in derivatives. That might help king fiat change into sturdier monetary clothes.
To me this scenario seems most likely. While short-term down drafts in PM prices may occur and many geopolitical and financial crises are in view, the accelerating pace of trade and currency facilities mating the RMB with other major nations and the continuing record accumulation of gold across Asia make the bullish case for PMs. The enormous net long positions in gold that banks recently have established add credence to the case that the deep and sustained PM correction is past or nearly past and a new level in gold's and silver's secular bull is set to begin. As a recent article noted, it is darkest before dawn but the ex-USD and currency moves that are about to include England, Canada and Germany (with France having expressed interest last fall) indicate an inflection point for PMs even as basic asset classes like equities and bonds wobble as the regime of credit expansion, debt and currency devaluation moves toward a more balanced reserve system.
Gold may be a cult for some, a flight to historical wealth from a world of flimsy values for others, but more importantly it is the basis for an emerging world reserve system. A larger question is the degree to which retail investors will be able to share in sounder monetary policies and a new role for the dollar. This will become plain in the next 6-18 months. In the meantime, energy stocks look strongest while PMs remain the greatest values for those not over loaded in the sector. Among large-cap miners, Goldcorp (GG) and Newmont are best. In the mid-tier space, Eldorado Gold combines productive and promising sites with little debt.
Additional disclosure: I own PM companies in two mutual funds.